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Friday, March 18, 2011

Amgen investors have high expectations for Amgen's Business Review Day, scheduled for April 21. With Medicare's coverage decision on March 16 settled in Amgen's favor (or at least not against it), their main focus now is on whether the big biotech will initiate a dividend. The question is tantalizing to Wall Street analysts, who are predicting that anything less than a positive announcement by the company will be a major setback for the stock.

Dividends have been an active, ongoing part of investor dialog with Amgen for several years. But very recently, the grumbling is getting louder, and Amgen is showing signs of capitulating. Until recently, the big biotech has refused to commit to a number or time frame. Now, apparently, executives have told analysts that they will provide a clear explanation of their capital allocation policy, presumably including dividends, on April 21.

Amgen's approach to dividends says a lot about its place in the biotech world and its strategy going forward, as well, perhaps, about the rise of shareholder activism. With its business maturing, and its growth prospects slowing, it is by far the largest of a small contingent of successful biotechs that are throwing off profits or expected to shortly. All of these companies – Gilead, Biogen, and, down the road, Vertex and Human Genome Sciences - are the subject of dividend questions, some more serious than others.

Most of these companies are sitting tight - HGSI and Vertex have yet even to launch products. And, after all, issuing a dividend means relinquishing a perception – or perhaps illusion – that a growth company can grow forever. Occasionally, one, like EU-based Actelion, the beleaguered maker of Tracleer, latches on to dividend payouts as a short-term, somewhat misguided and obviously desperate lollipop-attempt to respond to shareholder activists until the something it's waiting for happens (in Actelion's case, it wants favorable data from a late-stage compound to come out in late 2011 or early 2012).

With Genzyme and Genentech no longer independent, Amgen is clearly at the moment a special case. Its numbers tell of its maturity: 2010 revenues were roughly $15.1 billion, with growth in recent years ranging from -2.4% to +2.7%. Even with the launch of Prolia/Xgeva (denosumab) in the U.S. in 2010, Deutsche Bank analyst Robyn Karnauskas projects its top-line CAGR will only reach 2% between 2010 and 2014, although bottom line growth will rise 8%. Yet, it has the pharma industry's highest net margin, is sitting on $14 billion in cash (most of it stashed overseas), and generates $5.4 billion a year in free cash flow. With the exception of its purchase of BioVex in January 2011, it hasn't made a sizeable acquisition in years—if one can call BioVex "sizable". Investors and others insist that they want to know how the company plans to allocate this enormous amount of capital.

But what they really want is a clear articulation of Amgen's strategy. Analysts are divided on how comfortable they are with what Amgen's told them to date. They largely concur that the core franchise in anemia and anti-inflammatory drugs is set to decline slowly. Even if denosumab peaks at $3 billion to $4 billion, it is likely at best to contribute incrementally to overall long-term growth, Karnauskas says. The company has a sizable Phase II portfolio, but that will take time to mature and everyone knows the stats around R&D success.

Then there's the international question. Amgen has previously hinted that it is intent on making an acquisition that would be synergistic with its base business, perhaps one that is centered in the West but has a presence in emerging markets. Indeed, new CFO Jonathan Peacock, in comments that may have muddied rather than cleared the waters, indicated as much to analysts last year. More recently, on March 1, SVP International Operations Rolf Hoffman told a Citigroup Healthcare investors' meeting that the company "might consider non-organic options" to accelerate its global expansion.

Some on Wall Street fear the worst: a highly dilutive acquisition in a region of the world that is hard to value quantitatively and overshadowing any other news affecting the stock. Indeed, "If they are going into something we don't understand, they need to outline their strategy," Karnauskas argues. A sizable dividend would go a long way toward making investors more comfortable.

Ultimately, however, despite the hoopla, Wall Street expects Amgen will initiate a token dividend, yielding 1% to 2.5%. That should be enough to appeal to investors who are restricted to buying only stocks that pay dividends. But it won't eat up too much cash flow, especially in the long-term, when several key Amgen products go off line.

"The idea is that if you give a token dividend, those investors can 'check the box,' " says Karnauskas. On the other hand, for some investors, even 2% isn't enough, so Amgen might aim higher, at about 4.5%. About 10% of Amgen's annual cash flow would have to be dedicated to a dividend with a 1% yield, she says.

If this math addresses the logical part of the equation, it doesn't directly help the cultural transition from a growth to a value investment, which comes once a company enters the dividend world. Still, the move for Amgen may be unavoidable, as the market is already putting it in the value category, points out Standard & Poor's analyst Steve Silver.

The market is pushing less hard for other biotechs to change for now; indeed, the biggest step the next tier companies like Celgene and Biogen are taking to placate shareholders is introduction of stock buy backs. It behooves them to watch how Amgen maneuvers into a space where few biotechs have tread.

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